Spain will require a full-blown rescue package

Spain will require a full-blown rescue package

Good morning and welcome to today’s foreign exchange market commentary on Tuesday, the 24th of July.

Yesterday’s developments in Spain bring in focus what economists have been saying for a longtime, even though Madrid has steadfastly refused to accept it; it will require a full-blown rescue package. The Iberian nation’s sustained economic decline, fiscal deficit, high borrowing costs and precipitously high debt level (Too big to be rescued) brings us to the basic question: does the 17-nation currency fit the divergent needs of its member countries?

The divergences, often termed as fatal, include different growth rate, high disparities in current-account balances and differences in unemployment and job-creation rates which can all be traced to wide differences in unit labour cost.

Due to these reasons, risk premiums started rising in 2009 resulting in flight of capital that ultimately became rampant by 2011. A closer look at such high levels of capital flight would reveal that unsustainable policies of countries outside the eurozone have also helped the process. Structural inefficiencies in the UK and Hungary are as bad as some of the EU peripheral states, and they have either failed or chose not to exploit their currency flexibilities.

Moreover, the US and Japan has debt/GDP ratios comparable to some of the weak EU nations. On the other end of the spectrum, countries like Switzerland and Norway have pumped up high current-account surpluses that are more than 10 percent of their GDPs, but still resisting currency revaluation.

Germany was uncompetitive till it entered the eurozone in 2005 due to high inflation and excessive wages following its unification. Berlin gradually overcame them through structural reforms, which is also true for EU’s latest entrant Estonia, a country that became competitive in a short period of time though severe constraints on wages.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2790
GBP/US$ – 1.5506
GBP/CHF – 1.5368
GBP/CAN$ – 1.5798
GBP/AUS$ – 1.5065
GBP/ZAR – 13.0865
GBP/JPY – 121.44
GBP/HKD – 12.0406
GBP/NZD – 1.9606
GBP/SEK – 10.7727

EUR: The 17-member single currency witnessed a sellout yesterday as the perilous state of Spanish regional finances sent investors scurrying for cover. The EUR/USD pair fell to a fresh two year low of 1.2067, a level not seen since June 2010. The currency pair is trading below its average since the euro came into existence in 1999 over rumours that as many as six Spanish regions may seek help from an already indebted Madrid, forcing the Iberian nation to seek a full-blown bailout from the EU. Spanish borrowing costs hit a new Euro-era high, breaching the 7.5 percent mark that many believe is well-above the sustainable 7 percent scratch. Equity indexes slumped across Europe, forcing Spanish and Italian authorities to temporarily ban short-selling. The economic data calendar is light on the ground though some attention will be given to the European PMI number today.

USD: The continued weakness of the EUR/USD pair weighed on the cable yesterday with Sterling touching a one-week low of 1.5486 versus the greenback. Reports appearing in German media over the weekend that the IMF may suspend further Greece-aid unless Athens sticks to its bailout targets soured investor sentiments further, forcing investors to seek refuge in the world’s safest assets. The dollar index, a barometer of the greenback’s strength, gained as investors around the world piled up dollar denominated assets. The Q2 UK GDP number due Wednesday was also cited as one of the reasons for Sterling’s weakness as markets anticipate a soft reading for the third consecutive quarter. The cable is expected to track the EUR/USD pair in the absence of tier-1 economic data from the UK.

Have a great day!

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